Inside the Coasean Firm: Competence as a Random Variable

The work of Ronald Coase is notable for two primary reasons. First, it introduced the notion of transaction costs to explain the formation and maintenance of firms, Second, it advanced our understanding of the critical topic of social costs. Yet, while transaction costs are key to understanding why firms are organized, they do not offer a complete explanation of how they are organized. A richer account of the problem properly stresses that differences in individual levels of competence, as well as individual variations in temperament and taste, explain why, for example, some firms are organized as partnerships and others as straight employment arrangements, with many permutations in between. Understanding differential levels of competence also helps to explain issues in areas from employment discrimination law to capital markets and tort liability.